If one thing has become clear to many business owners this year, it is that in times of economic adversity, a clear overview of revenue and expense items is essential to the survival of a business.
It is at least as important to have a good overview of working capital. However, this is easier said than done. Nevertheless, there are a number of things one can pay attention to in order to make this as clear as possible. Optimal working capital makes a company more agile and thus better able to withstand an economic setback.
Revenue and working capital.
The most obvious, but at the same time one the most important, warning signs are declining sales. While most business owners have experienced one or two "disappointing" months, months of structurally declining revenue is, of course, a clear indication that the business is turning negative.
For this reason, it is important to analyze how sales are developing at an early stage. This will be different for many companies, but, for example, a customer who purchases much less from one month to the next deserves attention. For companies that have both one-time and also recurring revenue, the ratio between the two is important to keep an eye on. Proper classification of revenue is therefore essential and should be properly set up in the administration. Many business owners still look at the bank account to assess how the business is doing. However, a drop in turnover is often accompanied by a release in working capital. In that case, it takes a while for that to show up in the bank account.
On the other hand, where extreme growth often looks like a positive development at first glance, it can also be a threat. If the company is not set up for this sudden growth, the increasing working capital requirements resulting from this growth could quickly lead to a liquidity squeeze. In addition, excessive growth often leads to other problems as well. There is a real chance that focus on other important areas will be lost. Delivery problems lead to dissatisfied customers, and dissatisfied customers often foot the bill later. In addition, delivery costs will increase (e.g., returns). This further increases the liquidity squeeze.
Stocks
Many entrepreneurs do not have a comprehensive inventory administration with the result that the stock gradually expands or, on the contrary, that at certain moments 'no' has to be sold. Especially for companies that sell a multitude of products and supply spare parts, it is important to have a good inventory administration. A regular analysis of the turnover times of different stock parts quickly gives a good insight into products that are running fast or not. The ordering process can be quickly and efficiently adjusted accordingly.
Debtors
Dunning overdue debtors is an unloved activity for many business owners. Having to chase your money is never fun, and sometimes even uncomfortable. Yet it is important. A company with €10 million in revenue and debtor terms of 1 month, has a fixed core of debtors of about €1 million (including VAT). If the accounts receivable term increases to 1.5 months, this fixed core is already €1.5 million and thus €500K more needs to be financed. An increasing debtor term has the additional disadvantage that part of the VAT already has to be paid, while the debtors still have to pay. In addition, a late-paying debtor is not infrequently a dissatisfied debtor. The earlier you get in touch with the customer, the greater the chance that the dissatisfaction can still be removed.
Creditors
In times of downturn, you see that companies are quick to be inclined to pay creditors later. Unfortunately, many multinationals also use this method of working capital management, which threatens many entrepreneurs with liquidity problems. Nevertheless, it is also important for entrepreneurs to assess whether the creditor term is still optimal. It frequently happens that a discount can be obtained for prompt (or cash) payment. This is often very tempting to improve a company's returns, especially in comparison with the current low interest rates.
Example: 2% payment discount for payment within 7 days with a normal payment term of 30 days means 2% * 365 : (30 -7) = 31.7% effective interest!
Of course, there must be sufficient liquidity to actually make payments faster. Collecting a payment discount now, but not being able to pay salaries or taxes later in the month is of course not the intention. An overview of creditors that offer payment discounts in combination with a liquidity forecast can help you with this.
Conclusion
Working capital management should be an integral part of a company's efforts to be financially optimal. Too often, working capital is still a poor relation at many companies. Optimal working capital management (inventories, accounts receivable and accounts payable) makes a company more resilient in economically difficult times, but also in times of exuberant growth.
